CFTC Sues Binance & CZ

The CFTC has sued Binance and CEO Changpeng Zhao for allegedly offering unregistered crypto derivatives and encouraging U.S. customers to evade compliance controls using VPNs.

The United States Commodity Futures Trading Commission (CFTC) has taken legal action against cryptocurrency exchange Binance and its founder, Changpeng Zhao. The lawsuit, filed in the U.S. District Court for the Northern District of Illinois, alleges that Binance knowingly provided unregistered crypto derivatives products in the U.S., violating federal law. Furthermore, the suit claims that Binance encouraged U.S. customers to use virtual private networks (VPNs) to bypass compliance controls.

Binance Accused of Offering Unregistered Crypto Derivatives

The CFTC asserts that Binance conducted a derivatives trading operation within the United States. The exchange offered trades in cryptocurrencies such as Bitcoin (BTC), Ether (ETH), Litecoin (LTC), Tether (USDT), and Binance USD (BUSD). The lawsuit refers to these assets as commodities. Binance allegedly instructed its employees to use VPNs to hide their locations under Zhao’s guidance.

Binance faces numerous charges from the CFTC, including offering futures transactions, “illegal off-exchange commodity options,” failing to register as a futures commissions merchant, designated contract market or swap execution facility, inadequate supervision of its business, not implementing know-your-customer (KYC) or anti-money laundering (AML) processes, and having an ineffective anti-evasion program.

Following the lawsuit’s announcement, the price of bitcoin dropped by around $1,000, while Binance’s exchange token, BNB, fell by approximately 3%. Stocks related to cryptocurrencies also experienced declines.

Binance Allegedly Employed Deceptive Practices

The CFTC argues that Binance, which has a U.S. affiliate in Binance.US, designed a complex system to conceal its operations and reach. The lawsuit states that Binance’s use of numerous corporate entities was intentional, and meant to obscure the platform’s ownership, control, and location. The filing also notes that Zhao is accountable only to himself.

CFTC Chief Counsel Gretchen Lowe has labeled Binance’s actions as “willful evasion of U.S. law.” This characterization is supported by internal chats and emails provided in the lawsuit. The suit alleges that Binance instructed U.S. customers to use various methods to avoid restrictions on U.S.-based customers. Binance was reportedly aware of and encouraged U.S. customers to use VPNs to access and trade on the platform.

The lawsuit claims that Binance directed significant customers, such as trading firms, to establish shell companies in locations like Jersey, the British Virgin Islands, and the Netherlands to evade restrictions. Binance was allegedly fully conscious of its U.S. customer base’s extent, as internal monthly reports sent to Zhao indicated that even after implementing controls in June 2020, 17.8% of customers were still based in the U.S.

Binance Responds to the Lawsuit

A Binance spokesperson has stated that the company has invested heavily over the past two years to ensure U.S. users are not active on its platform. The spokesperson mentioned that Binance has expanded its compliance team from 100 to 750 people and spent $80 million on KYC and other compliance vendors and tools. While not addressing the specific allegations, the spokesperson expressed disappointment at the CFTC’s lawsuit, as the company has been collaborating with the CFTC for over two years.

Binance intends to continue collaborating with regulators in the U.S. and worldwide, emphasizing the importance of protecting its users and developing a clear and thoughtful regulatory framework. The spokesperson highlighted that Binance now enforces “country blocks for anyone who is a resident of the U.S.” and restricts “anyone who is identified as a U.S. citizen regardless of where they live in the world.” Furthermore, the exchange blocks U.S. cell phone providers, IP addresses, and bank accounts.

Internal Chats Expose Binance’s Tactics

The lawsuit cites internal chats between Binance employees, including Samuel Lim, the exchange’s chief compliance officer until January 2022 (also a defendant), where Lim appeared to instruct an employee to ask U.S. customers to conceal their location. The suit claims that Binance was aware that sanctioned entities and individuals were trading on its platform. Binance allegedly tasked an employee to serve as a “Money Laundering Reporting Officer” (MLRO) to write a report claiming its compliance audit was stringent, thereby hiding the inadequacy of its compliance program from business partners like Paxos.

The CFTC requests that the court prevent Binance from further violating the Commodity Exchange Act and impose civil monetary penalties, trading and registration bans, and disgorgement. Zhao, the exchange’s founder, tweeted “4,” referring to a previous tweet where he advised followers to “ignore FUD, fake news, attacks, etc.”

The lawsuit lists Zhao as a defendant, alleging that he was the “direct or indirect owner of entities that have engaged in proprietary trading activity on the Binance platform” and the “direct or indirect owner of approximately 300 separate Binance accounts” that participated in prop trading on the Binance trading platform.

In February, Binance’s chief strategy officer, Patrick Hillman, admitted that multiple regulators were investigating the exchange and that the company expected to pay fines to “make amends” for past regulatory violations. The lawsuit suggests that the CFTC had access to Zhao’s phone, as it was able to collect Signal text chains and group chats from the device.

Tokens as Commodities: CFTC Stakes New Ground

The CFTC’s identification of numerous major tokens as commodities in the complaint could signal a new approach to the jurisdictional question central to the U.S. crypto sector: Who is responsible for overseeing crypto trading? The Securities and Exchange Commission (SEC) has made it clear that it considers most tokens to be securities, with Chair Gary Gensler frequently stating that every crypto token, except for bitcoin, appears to fit this definition. CFTC officials have often suggested that bitcoin and ether are likely commodities, but they now also maintain that Litecoin and stablecoins tether and BUSD fall into this category. The SEC has previously implied that BUSD is a security in a Wells Notice sent to Paxos.

Gensler has specifically suggested that proof-of-stake tokens, including ether, are securities that should be registered and regulated by the SEC. However, the agency has not yet pursued enforcement actions to solidify this stance, and U.S. legislation providing a more permanent solution remains elusive. CFTC Chair Rostin Behnam promised last month that his agency would pursue a “strong year of precedent-setting cases” and has advocated for Congress to establish the CFTC as a leading watchdog for crypto trading in the U.S.

Following the collapse of the FTX exchange, U.S. lawmakers have expressed eagerness to advance bills addressing the largely unregulated crypto sector, with some focusing specifically on Binance. Earlier this month, U.S. senators, including Sen. Elizabeth Warren, sent a letter to Zhao questioning the company’s regulatory compliance and commitment to consumer protection. In response, Binance highlighted its investments in compliance infrastructure, its cooperation with U.S. regulators, and its desire to help shape responsible regulations for the industry.

Potential Impact on the Crypto Market

The CFTC’s lawsuit against Binance may have broader implications for the global cryptocurrency market. If the court upholds the CFTC’s charges, it could set a precedent that prompts other exchanges to bolster their compliance measures or face similar legal actions. Moreover, the case may encourage lawmakers to expedite the development of clear and comprehensive regulations for cryptocurrency trading, potentially leading to increased investor confidence in the space.

As the lawsuit against Binance and its CEO, Changpeng Zhao, unfolds, it is clear that the case represents a significant turning point for the cryptocurrency industry. Furthermore, with the CFTC asserting its jurisdiction over a broad range of digital assets and taking a strong stance against alleged violations, the landscape for cryptocurrency exchanges and their users may change dramatically. Binance’s response to these charges and the potential outcomes of the case will likely shape the future of crypto regulation and compliance in the United States and beyond.

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